Demand for mortgages at lowest level since December 2018 as bottom falls out of refinancing market.

After trending down since peaking during the first week of May, mortgage rates are headed up again this week as bond market investors weigh the Federal Reserve’s likely next steps to combat inflation.

Before a meeting on Tuesday, with Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell, President Biden said his top priority is fighting inflation, and that he respects “the Fed’s independence” and is “not going to interfere with their critically important work.”

The Fed has made clear that in addition to continuing to raise the short-term federal funds rate this year, it will begin trimming its nearly $9 trillion balance sheet this month, which includes $2.7 trillion in mortgage-backed securities that the Fed bought as part of its “quantitative easing” program to keep mortgage rates low during the pandemic and the 2007-09 recession.

The Optimal Blue Mortgage Market Indices (OBMMI) show rates on 30-year fixed-rate mortgages — which had been steadily declining since hitting a 2022 peak of 5.593 percent on May 6 — rebounding after the Memorial Day holiday weekend, rising 7 basis points from Friday to Tuesday to 5.344 percent.

A basis point is one hundredth of a percentage point. Tuesday’s mortgage rates were still 25 basis points, or one quarter of a percentage point, below their high for the year.

Mortgage rates rebound

That trend looks likely to continue, with yields on 10-year Treasury notes — a useful barometer for where mortgage rates are headed — up 10 basis points in midday trading Wednesday.

As the Fed looks to begin “quantitative tightening” — unloading some of the debt on its balance sheet — that could produce more interest rate volatility and upward pressure on rates, Reuters reports.

The Fed’s $9 trillion balance sheet

Assets held by the Federal Reserve through quantitative easing purchases now include $5.77 trillion in long-term Treasurys and $2.7 trillion in mortgage-backed securities. Source: Board of Governors of the Federal Reserve System, Federal Reserve Bank of St. Louis.

During much of the pandemic, the Fed drove down long-term interest rates to historic lows by increasing its holdings of Treasurys by $80 billion a month and growing its mortgage-backed securities portfolio by $40 billion a month. Although the Fed has stopped growing its debt holdings, it’s been maintaining them by replacing assets as they mature — and remains a factor in propping up demand for bonds and helping keep a lid on interest rates.

Fed dialing down purchases of mortgage-backed securities

Source: Monthly chartbook published by the Urban Institute’s Housing Finance Policy Center, “Housing Finance at a Glance,” May 2022.

Just to replace its maturing assets in April, the Fed had to purchase $35.4 billion in mortgage-backed securities — more than one-fifth of mortgage-backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae that month, according to the Urban Institute’s Housing Finance Policy Center.

With the Fed now embarking on “quantitative tightening” — letting that debt roll off its balance sheet — interest rates could come under more pressure.

Starting June 1, the Fed will begin reducing its mortgage investments by no more than $17.5 billion a month by letting maturing assets roll off its books. The plan is to ramp the pace of tightening up over three months, to $35 billion a month. The caps for Treasurys rolloffs will be higher — $30 billion a month at first, increasing to $60 billion a month after three months.

Without the demand created by the Fed’s purchases of Treasurys and mortgage-backed securities, the worry is that supply will outweigh investor demand. When there’s more supply than demand, that pushes bond prices down and yields up.

“The risk is the market is unable to absorb the additional supply and you do have a big adjustment in valuations,” TD Securities rates strategist Gennadiy Goldberg told Reuters. “We will still see more long-end supply than we did pre-COVID for quite some time, so all else being equal that should pressure rates a bit higher and the [yield] curve a bit steeper.”

The good news is that because mortgage rates have already risen by more than 2 percentage points this year, homeowners aren’t as eager to refinance their existing mortgages — which means the Fed may have a hard time hitting its targets for rolling off its mortgage debt.

At a press conference last month where Powell laid out the Fed’s quantitative tightening targets, he said it may not even be able to hit the initial $17.5 billion cap on rolloffs of its mortgage-backed securities.

“At the current level of mortgage rates, the actual pace of agency MBS runoff would likely be less than this monthly cap amount,” Powell said.

Demand for mortgages at lowest level since December 2018

In the meantime, demand for purchase loans fell slightly last week even as mortgage rates came down for the fourth time in five weeks, with first-time homebuyers facing the greatest challenges from this year’s runup in mortgage rates.

After adjusting for seasonal factors, applications for purchase mortgages were down 1 percent last week compared to the week before, according to the Mortgage Bankers Association’s Weekly Mortgage Applications survey.

Joel Kan

Purchase loan applications were down 14 percent from a year ago, but “with more activity in the larger loan sizes,” MBA forecaster Joel Kan said, in a statement. “Demand is high at the upper end of the market, and supply and affordability challenges are not as detrimental to these borrowers as they are to first-time buyers.”

While the average conventional purchase loan request was $460,800, the average request for FHA loans that are popular with first-time homebuyers, was $258,100.

If demand for purchase loans is weaker, requests for refinancing have fallen off even more dramatically, dropping 5 percent week-over-week and 75 percent from a year ago, the survey found.

Aggregate demand for mortgages, both purchase and refinancing, has fallen to the lowest level since December 2018, “as the purchase market continues to struggle with supply and affordability challenges,” Kan said.

For the week ending May 27, the MBA reported average rates for the following types of loans:

  • For 30-year fixed-rate conforming mortgages (loan balances of $647,200 or less), rates averaged 5.33, down from 5.46 percent the week before. With points decreasing to 0.51 from 0.60 (including the origination fee) for 80 percent loan-to-value ratio (LTV) loans, the effective rate also decreased.
  • Rates for 30-year fixed-rate jumbo mortgages (loan balances greater than $647,200) averaged 4.93 percent, down from 5.02 percent the week before. Although points remained unchanged at 0.41 (including the origination fee) for 80 percent LTV loans, the effective rate also decreased.
  • For 30-year fixed-rate FHA mortgages, rates averaged 5.20 percent, down from 5.36 percent the week before. With points decreasing to 0.69 from 0.82 (including the origination fee) for 80 percent LTV loans, the effective rate also decreased.
  • Rates for 15-year fixed-rate mortgages averaged 4.59 percent, down from 4.72 percent the week before. With points decreasing to 0.63 from 0.70 (including the origination fee) for 80 percent LTV loans, the effective rate decreased.
  • For 5/1 adjustable-rate mortgages (ARMs), rates averaged 4.46 percent, down from 4.49 percent the week before. With points decreasing to 0.68 from 0.76 (including the origination fee) for 80 percent LTV loans, the effective rate also decreased.

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Email Matt Carter

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